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Private Equity and Entity Investing
The following was written by Bruce Roberts, Founder and CEO of Carofin.
Private investing can be rewarding…but it’s always challenging. There are so many offerings to choose from, but each one is very different from the other. Investors need to apply an analytical approach to each private investment that is consistent and effective, while also efficient.
You can’t digest all the various details of a given opportunity at once, but you can organize your review by focusing on the key factors that determine whether a given investment is right for you – or otherwise merits further analysis.
Consider this a “first pass” framework to help you quickly obtain a fundamental understanding of a private security offering. It does this by prioritizing five areas of influence on the investment’s structure and eventual outcome – what we are calling the “Five Elements” (the “Elements”).
The Elements, once understood, establish a platform for more in-depth research – a full “due diligence” investigation. Investment analysis involves a journey where a relatively obscure, under-weighted detail can ultimately derail the investment’s performance.
But getting too granular too quickly in the evaluation process can also lead to a missing of the “forest for the trees.” This is about making sure an investor first achieves an adequate understanding of the forest.
The order followed during the investor’s analysis is also important. With Elements, an understanding of the private offering builds, step-by-step, as each Element is addressed.
Since each of the Five Elements interrelates, reviewing these topics in order enables the investor to gain an appreciation for how each pertains to the totality of the investment as an understanding of the investment unfolds.
The analysis should follow this simple sequence:
1. Purpose – Why is this capital being raised?
2. Issuer – Who is issuing the security?
3. Security – What type of investment is being offered?
4. Repayment – What determines the success of the investment?
5. Risks – What can go wrong?
Understanding a financing’s purpose – the “why” of a securities offering – provides the underlying context for each of the other Elements while also helping to reconcile whether what’s being presented to the investor makes sense.
An early understanding of the purpose of the underlying financing often enables investors to immediately determine whether they wish to keep exploring the investment opportunity. For example, does the investor want to be associated with the underlying business of the Issuer such as cannabis or alcohol production?
Identifying what the cash proceeds from the offering are to be used for also paints a clear picture of the offering’s purpose. Is it for short-term working capital needs or for longer-term business development? Are the funds supporting organic growth or to make an acquisition? Will the proceeds build the business or be used to make distributions to existing investors?
[Related: What is a “direct private investment?“]
The party carrying the financial obligations of the security is called the issuer. It’s vitally important to assess the basic nature of the issuer, its owners, and senior management since, collectively, they will have the greatest impact on the security’s performance. If you don’t understand who the issuer is, you’re not making an investment. You’re gambling…
A security is a form of financial asset held by an investor. Securities are “issued” by legal entities, such as corporations, to raise capital, for purchase by investors typically expecting to profit from the exchange.
Typically, a security is either in the form of debt or equity. Since each represents a very different obligation by the Issuer, it’s important to determine, early on, what type of security is being offered for investment.
Examples of securities include indebtedness (in the form of a promissory note) or ownership (equity in the form of shares or units), each of which is assigned a monetary value. For the security holder, it represents an investment with rights of ownership.
Video: Self-Directed Private Equity Investing Rules to Know
Once you know the type of security that is being offered, it’s important to understand how the investment, with its projected return to investors, will be paid by the Issuer.
Debt securities are generally repaid from the operating cash flow generated by the company’s ongoing business. Equity securities, on the other hand, are typically repaid through some event such as the sale of the company or by registering equity with the S.E.C., listing on a stock exchange, and through subsequent sales on the open market.
Every security involves the risk that it will not perform as expected for the investor. Conducting your Elements investment analysis as suggested above should highlight the major risks inherent to the security being offered, but there are other risks that can present themselves over the course of the investment.
Major categories of risk include:
As they say in Economics 101, there is no free lunch! Investment income is generally “earned” by investors through thoughtful investment analysis, consistently applied to investments – before they are funded by the investor.
Though the Five Elements are not all-encompassing, they guide an abbreviated process, early in the analysis process, for determining whether the commitment of time and other resources is justified for a more in-depth and time-consuming investigation. However, the Elements will provide essential context for the many other facts and details a deeper due diligence process will uncover (see Carofin’s Due Diligence Guidelines).
Carofin has created an extensive library of investor-oriented material within its Knowledge Base. We provide it to aid investors with their private investment analysis.
Financial terms used here are more fully defined in Carofin’s Glossary of Investment Terms.
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Bruce Roberts is the Founder and CEO of Carofin and has over 35 years’ experience as an investment banker and entrepreneur. 1987 – 1994, Mr. Roberts was at The First Boston Corporation (now Credit Suisse) in New York as a Director in the Investment Banking Department, supporting both corporate and government clients throughout the pacific region and raising in excess of $30 billion for his clients. He started his investment banking career at Bank of America in San Francisco in 1983. Prior to his investment banking career, he served as an officer in the U.S. Navy (UDT / SEAL).
Carofin is a FINRA broker-dealer specializing in the private finance of small to medium businesses in the U.S. Carofin and its affiliates have raised over $1.2 billion of equity and debt for smaller private businesses through over 200 securities offerings since 1996. We’ve learned a lot about financing SMB. Those lessons are reflected in every security we offer to private investors and in our continuing investor support after they’ve invested in our offerings.
Copyright Carofin, LLC 2020
Securities offered through Carofin, LLC, Member FINRA/SIPC. Carofin and Carolina Financial Securities are affiliated Broker-Dealers and subsidiaries of Carolina Financial Group, LLC. This material is published for residents of the United States only. Representatives may only conduct business with residents of the states and jurisdictions in which they are properly registered. Therefore, a response to a request for information may be delayed until appropriate registration is obtained or exemption from registration is determined. Not all services referenced in this material are available in every state and through every representative listed. For additional information, please contact Craig Gilmore at 828.393.0088 x 520 and/or [email protected]. Private placements are high risk and illiquid investments. As with other investments, you can lose some or all your investment. Nothing in this material should be interpreted to state or imply that past results are an indication of future performance nor should it be interpreted that FINRA, the SEC or any other securities regulator approves of any of these securities. Additionally, there are no warranties expressed or implied as to accuracy, completeness, or results obtained from any information provided in this material. Investing in private securities transactions bears risk, in part due to the following factors: there is no secondary market for the securities; there is credit risk; where there is collateral as security for the investment, its value may be impaired if it is sold.
Bruce Roberts not an employee of Equity Trust Company. Opinions or ideas expressed are not necessarily those of Equity Trust Company nor do they reflect their views or endorsement. These materials are for informational purposes only. Equity Trust Company, and their affiliates, representatives and officers do not provide legal or tax advice. Investing involves risk, including possible loss of principal.
Equity Trust Company is a directed custodian and does not provide tax, legal or investment advice. Any information communicated by Equity Trust is for educational purposes only, and should not be construed as tax, legal or investment advice. Whenever making an investment decision, please consult with your tax attorney or financial professional.
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